Does Westpac’s Decision Mean the RBA Will Cut Rates?

Yesterday, Westpac [ASX:WBC] announced a $3.5 billion capital raising and a 20 basis point increase on some of its mortgage products.

The knee jerk reaction from analysts is that this will allow the RBA to cut rates at its November meeting. In interest rate obsessed Australia, seemingly everything calls for a rate cut. That’s because we’re completely dependent on continuing asset price rises to keep our heads above water on household debt of more than $1.8 trillion.

But just think about the logic of it for a moment.

Westpac announced the increase in mortgage rates to help maintain its profit margins. Foreign funding costs, which in most cases accounts for around 40% of the big banks’ funding needs, has increased recently. This means that as banks roll over their debt from a few years ago, they do so at a higher cost, which hurts their profits.

Westpac is simply trying to offset this rise in costs. If the RBA turns around and cuts rates immediately, all it’s doing is asking savers to subsidise the banks’ profits.

Of course, that’s pretty much the whole point of interest rate cuts, but to do so in such a blatant and immediate fashion would put the RBA at the centre of the banking cartel’s operations.

Hang on…

Let me rephrase that.

It would make it plain to see for anyone with a brain that the RBA really does act on behalf of the banks and not the Australian people. So far, it’s managed to convince everyone that it is truly independent.

So I’m not getting too carried away with all this November interest rate cut talk. The RBA doesn’t want to blow its cover. Look for one in December instead.

The other point to consider is that the RBA’s chief weapon against a slowing economy is not interest rates. It’s acknowledged on a few occasions over the past few years that lower interest rates are not the answer.

As a result, it’s turned into Australia’s chief economic cheerleader. If only, the RBA says, we don’t succumb to pessimism. If only we can see the economy through beer soaked, rose coloured glasses, we’d be much better off.

Let’s see how that strategy goes…

Because while people try to get happy, reality just rolls on over the top.

And the reality is that we’ve loaded ourselves up to the neck with massive debt levels to speculate on housing. As a result, we’ve created an economic structure built around services to housing and asset speculation in general.

When the bubble bursts, we’ll be left with a completely inflexible economic structure. It won’t be able to adjust quickly enough and Australia will more than likely suffer a deep recession as it purges the excesses of the bubble years.

The RBA will attempt to avoid this reckoning by cutting rates further. But this will undermine the confidence they’re trying to create and spook foreign investors. Wholesale borrowing costs for the banks will increase.

The out of cycle interest rate rise you just saw from Westpac will become more common. At some point in this sorry saga, the RBA will lose control of the cost of credit and we’ll be at the mercy of our foreign creditors.

No wonder gold priced in Aussie dollars is only $200 an ounce off its all time highs. In the years ahead, it will climb much higher.

Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market.
To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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